Defensibility and Differentiation in Enterprise Tech Markets
Does enterprise software inherently become commoditized over time? That point was made several weeks ago on Twitter and it was no surprise that the person quoted was Fred Wilson from Union Square Ventures. I had heard the same point made by Fred in previous discussions which I previously just brushed off as his investment bias. As his thesis is tied to network effects businesses, his expertise and experience align more to the consumer side of technology. I think it is time however to revisit this issue before people start to take his point as a de facto truth.
Let’s face it, all technology over time becomes a commodity. When the iPhone first came out, it was novel and nothing came close in the market. Six years later, there are numerous options for smartphones that are as good or better than the iPhone. The same could be said of web browsers, email clients, note taking mobile apps, practically any category of software or hardware that was once innovative. Eventually a market becomes saturated with competitors offering similar products and features that are often better than what was offered by the first movers.
What is the difference then between those products that become market leaders and those that are left fighting for scraps? Often it comes down to execution and constant product iteration. In certain instances it will be strong branding. And in some cases, it is virality that spreads the word. For the most part though, it is usually a combination of these three elements that contributes to the rapid growth of a business.
To achieve market dominance however usually requires something else to keep competitors at bay. This is what people refer to as barriers to entry. Sometimes it is a patented technology and other times it is a business model that takes advantage of market irregularities or particular business arrangements. For example, Microsoft used its leverage with the operating system to spread into productivity suites and other areas of consumer and business software.
Then there are network effects businesses that Fred favors. The best examples are social networks where the value of the networks grows rapidly as more join. Messaging apps are experiencing the same growth characteristics. The advantage of such a dynamic is that they can rapidly scale because people get “locked in” to the network, meaning that it would be hard to get the same level of value on another service. Everyone they know is already part of an deeply invested in the existing network.
So are enterprise tech companies forever cursed to wage feature and function battles of ever more commoditized offerings? Or can they also take advantage of barriers to entry or some other means to remain distinctive and poised for healthy growth?
The answer is of course enterprise tech companies can build large scale businesses that are both defensible and differentiated. In fact, I would reject wholesale any notion that enterprise tech is somehow “commoditized” by its very nature. Such arguments ignore the realities of enterprise sales, the marketing dynamics and channels, and the fact that the companies and industries have their own unique idiosyncrasies that make any such assumptions of commoditization completely unfounded.
If we take the market for customer relationship management software (CRM), that alone has huge variations and permutations. One could look at CRM as oversaturated and lacking innovation, but in fact doing a search on “CRM” + “choose_an_industry” yields quite a few vertical offerings. Even when it comes to horizontal solutions, CRM is such a broad area covering sales, marketing, service, and any other customer facing function and entity, that specialties have from just one certain aspects of CRM, such as lead management or email tools or field service automation. Then that does not even consider areas of integration, data quality, analytics, ETL tools, and various technically oriented solutions for managing CRM. In other words, there are many areas in which to specialize and become the “best-in-class”.
This speaks to what makes enterprise technology such a fascinating and dynamic market. A startup can quickly create a sizeable business by targeting just a small slice of a broader market. Instead of trying to be a generic CRM solution or HCM product, you can be CRM for car dealerships or HCM for contingency workforces. Some of these slices might be small, but it is a start that could lead to other opportunities. Many started as a niche and then broadened out to become a platform for many functions or branched out to other verticals. And even a small slice can itself be a large billion dollar market, one that can be dominated by one main solution provider which has built up a network and industry expertise that creates that defensible wall against competitors.
That being said, from an investor standpoint I can understand Fred’s point. VC’s are not looking for modest exits in the tens of millions, they need those proverbial unicorn deals to provide the types of returns LP’s expect. That means many high quality early-stage enterprise tech startups may get passed over as “not defensible” or “not a large enough market” or “too niche” by investors. A consumer service or app has to be immediately understandable if it is going to have any chance to grow, and by extension such startups are easier for investors to evaluate. Enterprise tech startups however require more in depth knowledge and industry expertise in order to fully appreciate the opportunity.
For enterprise tech entrepreneurs, I would say stick to your guns and do not get discouraged. There are plenty of investors that focus on enterprise and understand well the market dynamics and potential upside. But more importantly, find that niche in which you can drill down into and own your slice of the pie. It is much easier to expand and go after the land grab if you can specialize and become the experts in a particular industry segment or core functionality. Creating product which exploits that deep knowledge and building a network within a segment will provide the type of defensible and uniquely differentiated solution that prevents you from being merely another “me too” commodity vendor.
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An excellent look into how enterprise tech startups should think about differentiation. One key aspect relevant to...
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